Personal Finance Ology

Compound Interest
Compounding interest can be a great way to increase your finances in shorter time period or beyond your originally desired amount. To understand the advantages of compound interest you must understand how it can work for you or against you.  Compound interest is used in many ways by banks. It is used to calculate the interest rates on your savings account as well as the amount of interest they will charge for a loan. Of course the interest you pay on your loan is going to be higher than the interest you earn on your savings account or CD from the bank. This is the way the banks make money. They pay you a certain amount of interest on your savings that will attract you to put money into your account and then they use the money in your savings account as a loan to another customer and have them pay a higher interest rate than what you are earning therefore making a profit.

*TIP: the current interest rate on loans and the interest rate on CD usually go hand in hand. If the interest rate on a CD goes up the interest rate on loans are sure to follow*

Either way compounding interest can help you to multiply your savings. Here’s how it works. Let’s say you put $10,000 into a savings account that pays a 4 percent interest. At the end of the year you would have a total of $10,400 in your savings account. This can be figured by using:

Future Value = Present Value x (1 + interest rate)^n

Where n is the number of years you are saving it.

However, if you are dealing with compounding interest the answer gets a bit more complicated but a lot higher. Compounding interest factors in the interest rate, the amount invested, the length of the investment and the periodic payments of interest. The basis of compound interest is putting your money to work for you. With compounding not only is your money earning interest but your interest is earning interest as well. When your interest earns interest you can begin to create an abundant financial future.

Starting a savings plan with compound interest early is a good way to increasing your finances. The longer you allow compound interest to work to better it will work for you. If you were unable to start saving at a younger age it is still ok to start now. Just know that you will have to make it a point to invest large sums so that you can get a higher return.

Related posts:

1. The Basics of Interest (Part Two)
2. The Basics of Interest: Part 1
3. Most Common Types Of Mortgage Loans
4. APR vs. APY
5. Savings Accounts